1 z swiss re new markets insuritization presentation to cas care seminar nick giuntini, fcas august...

1 ZSwiss Re New Markets

INSURITIZATION

Presentation to

CAS CARe Seminar

Nick Giuntini, FCAS

August 15, 2000


AGENDA

Insuritization

What is the Opportunity

Why Does it Exist

General Underwriting ApproachPossible Pricing Pitfalls / Issues


1) Definition

Insuritizition Placing risks that originate in the capital markets into the (re)insurance markets.

- e.g. wrapped bonds (credit enhancement)

<<vs.>>

Securitization Placing risks that would otherwise reside with (re)insurance companies into the

capital markets- e.g. cat bonds


1) Opportunities

Types of Risks where Insuritization has been/can be used:

Municipal Bond Insurance

CDOs

Project Finance

Royalty Streams

•film

•franchise

•drug

•music

NEW, ESOTERIC OR UNDERSERVED ASSET CLASSES ARE REAL OPPORTUNITIES FOR (RE)INSURERES.


Coupon - Decomposition

Coupon

Spread

Risk-free rate

Risk premium

Novelty Premiu

mCompensating the default risk of a non risk-free investment

Bonus for investing in a new asset class (novelty premium) - decrease over time

1) Capital Markets Pricing


1) Capital Markets Pricing

BBB / BB Spreads: New Assets verses Established Assets

-

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

450.00

500.00

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Sp

re

ad

to

Lib

or

CORP

ABS

N-ABS


150

60

175

70

350

240

325

270

0

50

100

150

200

250

300

350

400

Ca

t R

isk

An

nu

al

E(l

os

s)=

70

bp

s

Re

sid

ua

lV

alu

e o

f O

ilP

latf

orm

An

nu

al

E(l

os

s)=

20

bp

s

Au

to R

es

idu

al

Va

lue

An

nu

al

E(l

os

s)=

75

bp

s

PE

ME

X O

ilR

ev

en

ue

sE

(lo

ss

)=2

0b

ps

Insurance Market Distribution

Capital Markets Distribution

Sp

read

to

L

IBO

R

1) Pricing Comparison - Examples


1) Why is Capital Markets Pricing Higher for Certain Risks?

Illiquid Small Volumes of Risk Traded New Asset Class Lack of Coverage / Interest Uncertainty About Risk / Loss Estimates

Accumulating vs. Diversifying Risks (1 Sided vs. 2 Sided)


1) Accumulating vs. Diversifying Risks

Diversifying Risks 2 Sided Risks Natural Longs & Shorts Capital is not needed for risk if you can match up longs & shorts Generally most efficiently handled through Capital Markets e.g. Foreign Exchange Risk, Interest Rate Risk.

Accumulating Risks 1 Sided Risks Society is overall long in these risks Society net needs capital for these risks Generally most efficiently handled by entities that can diversify their

capital exposure with other accumulating risks (i.e. Insurance Cos.) e.g. Property Cat risk


1) (Re)insurer’s Competitive Advantages

Ability to underwrite & price difficult underlying risks, while separating or mitigating the risks that cannot be underwritten effectively

Ability to manage the risk within a diversified risk portfolio

High quality Ratings (i.e. AAA)


1) SRNM Risk Screening Process

Criteria for underwriting of Asset Backed Risks

Strong deal economics - lack of an efficient alternative market for the risk

Access to expertise, or ability to acquire needed expertise

Accepted model for the risk

Quality data that can be used to define the expected distribution

Low management risk or moral hazard risk


Un-Funded Solution

Derivative Transaction

Liquidity Facility

Surety

Financial Guarantee Policy

Insurance of Underlying Risks

Monoline Company as a Front

Funded Solutions

On-Balance Sheet

Off-Balance Sheet - Conduit, Repo, Total Return Swaps, Rented CP Facilities

1) Form of Risk Transfer


2) POTENTIAL PRICING PITFALLS / ISSUES

Alignment of Interests / Moral HazardTrend or Cycle?Too Little Data“Too Much” DataChange in Underlying Process Inappropriate DataOver-Reliance on Linear Regression“Trending, Developing & On-levelling”others...


2) Alignment of Interests - Moral Hazard

“We wouldn’t have done these deals had they not been insured”

- John Miller, Managing Director - Chase Securities

In reference to insured film loans where claim have been filed against the insurers. The insurer’s, however, claim that they were relying on Chase’s track record of historically successful film lending.

WSJ - July 20, 2000


2) Trend or Cycle?

Are current oil prices part of a trend or just a temporary peak?

Annual (June) Oil Prices

10

15

20

25

30

35

1983 1985 1987 1989 1991 1993 1995 1997 1999

Year

Price


2) Too Little Data

Largest US Cat Loss per Year

-

5.0

10.0

15.0

20.0

25.0

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

Year

Tot

al In

sure

d Lo

ss in

199

9 U

SD

, Billi

on


2) “Too Much” Data

“We used 17,500 data points to predict the price of electricity.”

This will show the price of electricity as a function of gas prices, temperature, generating capacity, time of day, and day of week.

However, these data points are only 2 years worth of information (hourly observations).


2) Change in Underlying Process

California WC C/Rs

80%

90%

100%

110%

120%

130%

140%

150%

1988 1990 1992 1994 1996 1998 2000

Accident Year

Com

bine

d R

atio

@ 1

2/31

/99

Start of

Open Rating


2) Inappropriate Data

Stock Price Movements

25

30

35

40

45

50

55

60

65

19-Jul-99 07-Sep-99 27-Oct-99 16-Dec-99 04-Feb-00 25-Mar-00 14-May-00 03-Jul-00

Year

Pric

e

Ford ATT

Correlation between daily price movements is 2%.

However, correlation when Ford is down at least 3% is 24%.


2) Over-Reliance on Linear Regression

Regression estimate would have dramatically overestimated new stores.

Annual Store Openings - Restaurant Chain

0

50

100

150

200

250

1978 1983 1988 1993 1998

Year

Nu

mb

er

o f

Ne

w S

tore

s


2) “Trending, Developing & On-Leveling”

Mortgage Portfolio Delinquency Rates

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

as a

% o

f Out

stan

ding

Por

tfolio

Data not adjusted for economy or increasing size of portfolio.


CONCLUSION

Big Opportunities for (Re)Insurers

Risk Understanding & Quantitative Analysis Crucial Be Careful Make Informed Judgements Where Uncertainty Exists - Be “Conservative” Include both Insurance & Finance Perspective

1 z swiss re new markets insuritization presentation to cas care seminar nick giuntini, fcas august...

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